Questions about independence

In my job as part of a consultancy company, I know there are two types of reports our clients are interested in—those that are written for the customer to be used internally and those that are to be used externally. Quite often, instead of well thought out and researched pieces, these last-mentioned reports are created simply to underscore the opinion of the party paying for them.

So when I received research by AT Kearney on A Viable Future Model for the Internet, I immediately checked who had paid for that report. On seeing the names Telefonica, Deutsche Telekom, Telecom Italia and France Telecom I could almost predict the viewpoint that the paper would present—that content companies should also start paying the incumbents for the delivery of information over their networks—this despite the fact that the users are already doing that. And, given that it was the European carriers who commissioned the report, the American content providers are, of course, the main target.

Unfortunately, despite AT Kearney’s claim of independence on both its website and in the paper, I was right. That is precisely the tone of the paper.

It can be summarised as follows: traditional telecom companies are to be pitied. They invest enormous amounts in new infrastructure, but no matter what they do the content guys (Google, Apple, Amazon, Netflix, Facebook, Skype) are pushing the pipes full of digital information, making it necessary for the telcos to make more and more investment in their network.

Slam a tax on the Internet, to be collected by the telcos

All this because the content companies aren’t paying for access to the telco networks. And even more exasperating for them is that the content providers are doing extremely well in the process and the telecos are being pushed back into network provision. Nowhere does AT Kearney acknowledge that these incumbents were the first to have the opportunity to become involved in the content business, but their greed and monopolistic behaviour saw a total failure of their attempts to use proprietary portals and walled gardens to enter this market.

Through open networks, innovations and competition, companies such as Google became far more successful than the telcos. And since the incumbents haven’t been able to beat the new Internet companies via competition they now want to use their monopolistic muscle to introduce something that looks very much like a tax on content, to enable them to continue reaping monopolistic rents from the market or, alternatively, to use differentiation in quality between premium and low quality content.

AT Kearney proposes that telecoms companies be allowed to:

1. Charge content sites €0.05 per gigabyte to send data to fixed networks and €3.03 to send it to mobile networks.
2. Charge differently for premium content etc.

They claim that this would compensate the incumbent telecom companies for their efforts and lead to a fair distribution of income.

Continuation of monopolistic behaviour

This line of reasoning is not new. It has been the incumbent telcos’ party line ever since the Internet became popular in 1994. The International Telecommunications Union is forever besieged by telecom companies from developing countries to push this idea. In the USA the issue has become very political, with President Obama personally stating that the Internet should stay open and that telcos can’t use their position to differentiate between content (net neutrality).

The vertically-integrated telcos would like to keep the telephony world the way it used to be, and in most countries still is. This is how it goes ...

The receiving network of a phone call can charge anything it wishes and the originating network will make sure the caller pays the bill, whether it’s fair or not. The customer has no say in this; they simply have to pay whatever the telco charges. Decades of hard-won regulatory reform have been necessary to keep these somewhat prices in check. However global dissatisfaction regarding telephone prices clearly shows that, despite government and regulatory intervention, this system is still far from fair.

On several occasions regulators have indicated that this system is indeed not an equitable one and they have also pointed out that regulating these vertically-integrated telcos is extremely difficult.

The network receiving a telephone call is in the position to request arbitrary amounts from the originating network—and neither network operator cares, since the consumer pays this anyway and they both receive a cut. This is not—and has never been- a transparent process.

This leads to high termination rates for calls, in particular calls to mobile networks and international calls. Regulators have to regulate these rates but they are constantly besieged by lawyers and economists working for telecoms companies.

The result is that it takes forever (more than 20 years) to get the rates down and there are enormous differences between nations. For instance, in Singapore the rate is zero. Their operators do not pay each other at all for sending or receiving a call from another network. In India it is less than a cent per minute. In many other countries it could be as high as 22 cents per minute to call a mobile, but that is now going down dramatically, with the European Commission aiming for prices of around one cent per minute. Also in Australia and New Zealand regulations are in place to produce a (far too gradual) decline in these costs.

Let competition decide what users should pay for Internet services

There is, however, an ideal world from the regulatory perspective—the Internet.

The Internet has shown how data can be sent all around the world in an equitable way, with competition leading to ever lower prices. The unique thing about the Internet is that each network will have to make money from its own customers and not from someone else’s. This is logical way to carry on any business—someone who isn’t your customer is not going to give you money.

In the world of the Internet nobody gets a free ride. The only way you can connect is if you pay, and the more you use the network the more you pay. The good thing, however, is that the customer can choose who they spend their money with. In principle, the more customers an ISP has the lower its costs will be, and the lower its prices will be. So ISPs and content providers alike try to get more customers, and to get global connections at lower prices.

If they can bypass their national incumbent network supplier and get lower costs by connecting directly to other (competitive) networks on a different continent they will. A good example is Google, which became part of a consortium that is laying a fibre optic cable across the Pacific—in the long run this investment of hundreds of millions of dollars is cheaper than using the networks from the incumbent national telcos.

This puts pressure on the network providers to continue to reduce prices, and to do this they need more customers and lower costs themselves. This is how normal business works. However incumbent telcos are very worried about competition since in the past they had little or no competition and were able to charge what they liked.

AT Kearney proposal would lead to regulatory nightmares

The AT Kearney model would bring the Internet to a standstill, similar to the lengthy telephone network regulatory processes that in some instances dragged on for a decade before a resolution was found. Their suggestion is that similar processes need to be implemented in relation to Internet services.

The AT Kearney argument is that different networks have different costs and therefore should be allowed to charge someone else’s customers different rates. Their proposal, for instance, assumes that fixed networks are cheaper than mobile networks and so mobile networks should receive 60 times more for the same data.

But building a national fibre network like Australia’s NBN will be more expensive than building a mobile network. So under their proposal Australia should be allowed to charge even more than European mobile networks. Imagine the negotiations that would be involved in establishing what that rate would be!

For argument’s sake, let’s say the NBN is five times more expensive than a European mobile network. That would be €15.15 for every gigabyte the Europeans send to Australia and only €0.05 for Australia to pay when a European uses his cable or DSL connection to visit a website in Australia. It sounds like a perfect deal for NBN Co. All they would need to do is encourage Australians to visit European websites and the NBN will be financed by the Germans, Italians, French and Spanish, who would have to pay those phenomenal connection rates.

The reality, of course, is that in such situations websites will just block all foreign visitors, all mobile and fibre users, etc. Countries would be in an ‘arms race’ to increase the prices and international use of the Internet would come to a halt—in just the same way that international calling was almost non-existent in the period before competition on the international calling market erupted.

This would a paradise for the lawyers.

Considering a different approach

I favour a totally different approach. If countries want to move ahead and have broadband networks that are capable of carrying the data they anticipate in the future, they will have to build and finance these themselves. It may sound good to say that the American content providers need to pay for these networks, but then the Europeans that are covered in the proposal will have to pay those rates on their networks.

In the competitive and open Internet environment any content provider, wherever they are in the world, is free to compete with others.

Furthermore, as any utility company can tell you, there is good money in a national or regional monopoly for an essential utility. And some of the telcos are already exploring different business models for content and infrastructure (KPN, BT, Telstra, Telecom New Zealand, SingTel). Infrastructure may not sound as spectacular as content, but we must never forget that Google’s revenue is only 10% of that of any of the four telecom companies who commissioned AT Kearney to write the report. Their combined revenues and profits for any single year are about as much as Google has made up until now.

However, the model they and other content providers choose is totally up to them.

Many truly independent observers believe Australia has a winner with the NBN. Europe still hopes that competition will deliver them multiple competing fibre networks. I don’t think this will happen—the costs are too high and the risk of the competing networks going bankrupt is too great, and I therefore do not believe that financiers will have the nerve for it.

Just as Telstra did in Australia, the European incumbents are exploiting this. What they fail to explain, however, is why giving them more money (e.g. though a content tax) will magically encourage them to invest in a better network, rather than simply handing over more to their shareholders. By creating a national broadband utility Australia has made a sound investment that removes this problem.

Check it all out for yourself: AT Kearney report [PDF]